BUSINESS CYCLE AND OPTIMAL TIMING FOR INVESTMENT

Joseph Cheng, Jeffery Lippitt

Abstract

The objective of this paper is to determine which point of the business cycle offers investors the best reward to risk ratio in the stock market. Expected reward is defined as expected return in excess of the risk free rate, whereas risk is defined as the standard deviation of return. Thus, the expected reward to risk ratio is measured by expected return in excess of risk free rate relative to the standard deviation of return. Expected return in excess of the risk free rate and standard deviation of return are generated on a continuum of time periods and the GDP growth rate. The point where the expected reward to risk ratio peaks, would signify the best time for investment. Being able to identify this point could help investors in deciding the best time to invest as well as help firms in choosing a favorable time for raising equity capital. While most people think that the best time to invest is near the bottom, it is not clear whether the best time for investing is before, at, or after the economic trough. The interesting finding in our model is that the best time is after the point of the economic trough.